-- While construction is complete, the main risk lies with the retained facilities, for which the ProjectCo is responsible for hard and soft facilities management (FM) services. Even though the “Schedule 38” amendment to the project agreement for dealing with areas not yet at the necessary standard (“Condition B”) has been formally executed by all the parties, the Trust will continue to apply deductions where the retained facilities do not meet the required standards.

-- ProjectCo is exposed to the risk of increased costs for hard FM, although a separate reserve partly mitigates this risk. The project is exposed to the uncertainty of more than 30 years of capital replacement costs. The capital replacement risk is somewhat mitigated by a three-year forward-looking life cycle reserve and a 12-year guarantee by the construction contractor for serious latent defects.

-- The project’s financial structure is aggressive, which is typical of the PFI sector. The ratio of senior debt to total funds is 93% (excluding receipts from the Trust); the debt amortization profile is back-ended (60% matures in the last 10 years of the life of the bond and 36% in the last five years); and the base-case senior debt service coverage level, without interest income, is 1.14x (minimum) in March 2025 and 1.16x (average), which is weak but in line with other PFI projects in the U.K.

These risks are offset by the following credit strengths:

-- The revenue stream is based on availability, with little volume or market exposure, negligible reliance on third-party revenues, and a payment mechanism that, in the view of the independent technical adviser (TA), is largely benign.

-- A commercial settlement has now been agreed that settles certain service failure points (SFPs) awarded to ProjectCo and also agrees the scope of ProjectCo’s responsibilities within the retained estate. This removes some uncertainty and allows ProjectCo to manage its operating risk in the retained estate.

-- The relationship between ProjectCo, FM service provider Skanska Facilities Services (SFS), and the Trust has improved. We understand that a good rapport has developed and the parties are willing to work together. Regular meetings, independent audits, extra resources, and a positive attitude have all helped foster an improved relationship among project parties.

-- The hard FM services provided by SFS have improved with only minor service failures. SFS is now aiming for zero performance deductions. The Trust, ProjectCo and SFS are working together to close out the issues raised in the various audits and have closed the majority of them.

Project update

NHS Foundation Trust regulator Monitor appointed an interim chairman and chief executive at Sherwood Forest Hospitals NHS Foundation Trust after the incumbent chair stepped down in October 2012 following the Trust posting a deficit of close to GBP6 million for the first quarter of 2012/2013 along with concerns raised on clinical tests for breast cancer. This intervention by Monitor aims to review the quality and safety of the Trust’s services, especially the breast cancer treatment issue, and to ensure robustness of its governance. However, we continue to believe that this intervention will not impact the operations or payments to the PFI hospital and will ensure continued delivery of services.

A draft deed for the postponement of the first market testing of the soft FM services provided by Medirest is under circulation, which would move the date to April 2017 for all soft FM services except waste services and to November 2014 for waste services after it is signed and accepted by all the concerned parties.

Liquidity

As of Sept. 30, 2012, the project’s liquidity is sufficient, in our view. The project holds of GBP1.07 million in cash and other reserves such as a GBP9.36 million six-month debt service reserve account, a GBP1.289 million life cycle reserve account on a three-year forward-looking basis, a change in law reserve of GBP6.73 million, a hard FM reserve account of GBP1.5 million, a car-parking reserve of GBP1.0 million, and an insurance premium risk share reserve account of GBP0.92 million.

Outlook

The stable outlook on the SPUR reflects our view that ProjectCo and the Trust will maintain a good relationship and that provision of services will be maintained at current levels. This follows the completion of construction, the agreement of a commercial settlement to resolve concerns related to the retained estate, and the project’s overall improved performance.

We could lower the SPUR if the project were to become exposed to potential risks or liabilities arising from the commercial settlement that strain the relationship between the Trust and the ProjectCo, or if the project were to incur deductions due to nonperformance of the FM services provider. On the other hand, we could raise the SPUR if, following the finalization of the commercial settlement, the project were to perform better than forecast and the relationship between the parties improves further.

The stable outlook on the insured rating reflects the outlook on the rating on the bond insurer, AGE, and will be revised in line with any changes to the rating or outlook on AGE.

Counterparty exposure

As per our criteria “Project Finance Construction And Operations Counterparty Methodology,” published Dec. 20, 2011, we assign a Counterparty Dependency Assessment (CDA) to counterparties that are material and cannot be easily replaced without significant time or cash flow implications. Given the irreplaceable nature of the Trust as the offtaker, we apply a CDA equal to that of Standard & Poor’s view of the credit quality of Sherwood Forest Hospitals National Health Service Foundation Trust.

In our view, there is no need to apply a CDA in relation to the hard FM services provider SFS as it can be easily replaced, the services provided are straightforward, and there is sufficient credit enhancement through internal cash reserves to cover the cost of replacement if required. The same argument applies to the soft FM provider, Medirest Ltd. (a subsidiary of Compass Group PLC (A-/Positive/--), since it is easily replaceable and the services it provides are straightforward.

Related Criteria And Research

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